Turbulent Waters for SAIL: An Opportunity to Sell Rails

Sarvvijayee, Partner with one of the Big Four strategic consulting firm has over two decades of rich experience in consulting withmetal and infrastructure industries. He has worked on varied domains including industry consolidation, assessing the impact of economic cycles, suggesting holistic go-to-market strategies to working with major industrial firms in improving their key performance indicators (KPIs).

Off late, one of the largest steel player in India has approached him with a tender enquiry. The enquiry has been initiated by the steelmaker, post the announcement by Indian Railways citing the intention to end its exclusive contract of Rails purchase with SAIL (Steel Authority of India Limited) and opening the doors to invite private players for meeting domestic rail requirements.

The steel player wanted to engage Sarvvijayee in assessing the potential of the opportunity and also to suggest ways to align the same with the product portfolio, financial standing and potential profitability of the firm. Similar is the case with other Indian steel players who are eyeing this opportunity and are re-assessing their strengths and weaknesses to leverage the same.

Sarvvijayeeand other strategy consultants who have been approached for this,are comprehending the complexity of this enquiry given the huge opportunity underneath and the competitive intensity to convert the same by the steel players. They are pondering over the multi-dimensionality of the issue, analyzing and re-analyzing the sentiments for Indian economy and the steel companies before suggesting anything to the aspiring steel players.

What are the growth plans of Indian Railways? What shall be the quantum of the resource and investment requirements for the steel players to cater to this opportunity? Whether companies should respond by promising installation of new capacity to take on SAIL's monopoly all alone or should they partner with some experienced player to expand their product range?Will they be able to install dedicated steel plants for Indian Railways?

Government to end monopoly of State-Owned enterprise over rail supplies

With the increase of 25 percent in train accidents due to track defects in past two years (2014-2016), the Government had to introduce a $15 billion safety fund . Now, the State rail operator (under the aegis of Ministry of Railways)has undertakena mammoth task of modernizing the Indian rail network (the fourth largest globally) over a five year period at an estimated cost of $130 billion.Indian Railways have audacious plans to revamp 3,500 kilometer long tracks by the end of 2018. Railways need to cough up INR 10,513 crorefor this project .However, this drive is currently facing the heat due to ageing tracks and saturated capacities.

The SAIL's Experience

SAIL, a public sector steel producer has enjoyed the monopoly in supplying all the rail requirements for rail tracks for past 30 years. This was the result of an exclusive supply contract entered by Ministry of Railways with SAIL in 2003. However, in 2016 for the eighth time in past ten years, SAIL once again has failed to meet the demand for rails by Indian Railways to the tune of 250,000 tonnes which is highest in terms of volume since the inception of the contract in 2003.

Additionally, the sudden and massive jump (45%) in demand for steel(for rails) by Indian Railways since 2015, aggravated by the delay on part of SAIL to revamp its production has forced Ministry of Indian Railways to look for other private steelmakers for supplying enough rails. As per the report by Business Standard , Ministry of Indian Railways may soon come up with a global tender in order to procure 250,000 tonnes of rail tracks from private players across the world. This may imply opening up plethora of opportunities amounting to $700 million per annum  for the private players.

This policy intervention might promote steel demand in the country and benefit the private steel players who are ailing due to cheap imports of long and flat products from China, Japan, South Korea and Russia (the cheap imports have forced domestic steel industry to cut their prices, which has further squeezed their margins).

Present Scenario of Rails in India

• The rails are considered to be the most important component of railway system. The standard length of rail in India is 13 m, although 26m-long rails are also used at some locations. The rails are welded by aluminothermic welding process and the normal rails are made of steel containing 0.7% carbon (C) and 1% manganese (Mn) and are called 'C-Mn' rail steel. From a strength perspective {ultimate tensile strength of 880 Mega Pascal (MPa) or 90 kg/mm2}, the 'C-Mn' rail is popularly known as '90 UTS' rail or 'Grade 880' rail.
• Safety concerns and economy of operations has forced railway operators world over to switch to long rails with limited weld joints. Bhilai Steel Plant (BSP) is currently producing 65 meter single piece rail, which are welded to 130 or 260 m as per the order with the modern machine supplied by Elektriska Svetsnings-Aktiebolaget (ESAB), Sweden. Another type of rails that have gained prominence lately are 'Head Hardened Rails'. Head hardened rails are typically used in metro rail projects and for high speed freight corridors. They are manufactured through a special heat treatment process which requires precise temperature control to achieve nearly 50 per cent higher hardness as compared to a normal rail. The landed price of imported head hardened rails hovered around INR 75,000 per ton in September 2016, while imported normal rails costed INR 50-55,000 per ton during the same period.
• Recently, SAIL has commissioned a new Universal Rolling Mill (URM) at the cost of INR 1,200 crore. This new URM shall be able to produce world's longest single piece rail of 135 meter as rolled length and 130 meters as finished length. This new URM will be world's largest in terms of its rated capacity of 1.2 million tonnes per annum (MTPA).
• For laying a kilometre of rail line, railways use 260 tonnes of steel. Government has set the target of laying 7 kilometres of new rail tracks everyday (or 2800 kilometres for fiscal 2016-17) and has envisaged target of ~19 kilometres per day in 2018-19 . The demand for rails by Indian Railways is expected to be around 1.35 million tonnes this year, whereas SAIL can supply 1.1 million tones only. This clearly highlights the gap which needs to be bridged.

The domestic steel industry has been in stress from past three years (2014-2016) due to the global recession witnessed by theindustry, worsened by the onslaught onmargins of domestic steel players due to dumping of the steel products by countries like China, Japan & Russia.

However, the industry has shown some signs of recovery after the policy interventions and anti-dumping measures by the Government agencies.Industry experts are of the opinion that Government's effort in increasing infrastructure spending is going to give a major boost to steel demand in the country through 2020-21.

The biggest problem for the steel players is their gigantic contribution to the Non-Performing Assets (NPAs) of some of the major banks of the country. Most of the major and small private steel players, except Tata Steel & JSW (Jindal South West)are today under the debt restructuring plan of the banks. The Industry is bound to witness a significant consolidation in the market over the next two or three years, marked by paradigm shifts in the strategies and management of the major steel players.

Company Profiles of Major Steel Players:

1.    JSW: O.P. Jindal group's entity JSW Steel Limited (JSW) is engaged in the manufacturing of iron and steel products . The company currently manufactures hot rolled steel strips sheets/plates, MS cold rolled coils/sheets, MS galvanized plain/corrugated/color coated coils/sheet, steel billet, bars and rods. The company is not engaged in manufacturing of rails or related products as of now.As on date, JSW's steel plants are located in Karnataka, Tamil Nadu and Maharashtra. Their combined installed capacity is 18mtpa.

2.    Tata Steel: Tata Steel Limited (TSL) has an annual crude steel capacity of ~29.0 mt at present, which maydecrease to ~18.9 mtpa post the proposed exit from the UK long and flat steel businesses. The domestic crude steel capacity of the company stands at 16.0 mt of crude steel. The company is also running operations in Thailand and Singapore. TSL has production units at Jamshedpur (Jharkhand) &Kalingnagar (Odisha).The product range of company comprises of both long and flat products and is currently not having any facility to manufacture rails in India .

3.    SAIL: SAIL has five integrated steel plants (with an installed capacity of 12.8 mtpa of saleable steeland is currently undergoing expansion) and three special steel plants for manufacturing alloy steels and stainless steel. The Bokaro (Jharkhand) and Rourkela (Odisha) units are engaged in manufacturingof flat products; the Bhilai (Chhattisgarh) and Durgapur (West Bengal) units manufacture longproducts and rails; and the IISCO steel plant at Burnpur (West Bengal)manufactures structural products.

The other three plants are special steel plants viz., Alloy steel plant (ASP) at Durgapur in West Bengal with an installed capacity of 184,000 tonnes per annum (tpa); the Stainless steel plant (SSP) at Salem in Tamil Nadu with an installed capacity of 175,000 tpa; and Visvesvaraya Iron and Steel Plant (VISL) at Bhadravati in Karnatakawith an installed capacity of 98,000 tpa . The Government of India (GoI) currently holds 75% stakes in the equity capital of the company and has plans to disinvest three special steel plants in the near future .

4.    JSPL: Jindal Steel & Power Limited (JSPL) is one of the major steel companies in India that manufactures wide range of steel products such as sponge iron, mild steel, structurals, rails, pellets & plates. It has two production units, one in Raigarh (Chattisgarh) and the other in Angul (Odisha). They both have a combined capacity close to 5 million tones. The company is also having a manufacturing unit in Oman.

Naveen Jindal-led JSPL has a total rail manufacturing capacity of 60,000 tonnes per month including 30,000 tonnes for head-hardened rails. JSPL is eyeing addition ofINR 3,500 crore in its turnover figures from rails division in next 2-3 years.

Currently apart from SAIL, it is JSPL only that has facilities to manufacture rails. JSPL has bagged a contract of supplying 150,000 tonne of rails to Iran, comprising 130,000 tonnesof normal rails and 20,000 tonnesof specialized head hardened rails .

JSPL: Experienced a Failed Attempt to Put Brakes on SAILs Monopoly Jindal Steel & Power Ltd. (JSPL) after starting operations of Rail and Universal Mill strived hard to get supply contracts from Indian Railways for the same. However, JSPL's concerted efforts could not garner orders due to the exclusive service agreement that Indian Railways entered with SAIL in 2003. In order to bring down the entry barrier, JSPL approached Competition Commission of India (CCI)  in 2009 with the following demands :

a.    To direct SAIL to end the exclusivity obligations with Indian Railways
b.    To impose fines on SAIL in accordance with Section 27  of the Act for enteringinto an anti-competitive agreement
c.    To introduce competitive bidding arrangement in the relevant market for the purchase of rails
d.    To pay relevant costs to the information provider
e.    To pass any order the Commission deems fit.

After several round of deliberations, CCI held the view  that agreement between SAIL & Indian Railways was not anti-competitive due to following reasons:

a.    Indian Railways action in selecting SAIL for the supply of rails was justified at that time, as there was no competition in the market. It provided security for supply of Research Design & Standards Organisation (RDSO)compliantrails tominimize the transaction cost and the cost of uncertainty, which is of immenseimportance for a national transport network like Indian Railways.SAIL is a more efficient supplier of rails than JSPL because of its welding capability deepened by thefactthat it has been continuously upgrading its quality of rails to provide for longer rails capable of taking heavy loads, whereas JSPL's rails were still under field test. The report on the rail market exhibited that the supply of rails to non-Indian Railways entities amounts to 25% of the total rails market and hence, SAIL cannot be said to be hindering competition or creatingAAEC (Appreciable Adverse Effect on Competition) in India.

b.    The MOU between SAIL and Indian Railways is rational on the basis of both price and quality and is not anticompetitive. SAIL has continuously upgraded to meet the standards which are internationally comparable. Large scale operations of SAIL reflected that its profitability would not be affected even if the Memorandum of Understanding (MOU) was not signed. Therefore, no intention of anti-competitiveness can be inferred from the MOU.

Consequentially, the CCI held that neither SAIL nor Indian Railways had contravened any provisionsof Competition Act.  AlthoughJSPL could not enter intocontractwith Indian Railwayseven after approaching CCI, however, it has been supplying rail tracks to leading infrastructure companies such as Delhi Metro, Kochi Metro, L&T, NTPC, Tata Steel, JSW etc. JSW is keen to supply the new rail products for metro rails and bullet train and has bagged order from the Dedicated Freight Corridor Corporation of India Limited (DFCCIL) & railway projects in Iran.

The current opportunity of opening the doors to private steel players by Indian Railways, has once again raised the hope of JSPL to supply the rails to Indian Railways. Further, due to modernization and othervisionary projectsinitiated at JSPL, it may enter intocontract with Indian Railwayswhich may now be of comparatively higher volume than that of the past.

Road Ahead:

The domestic steel industry has been under pressure due to cheap imports in the past decade. Government has taken concerted efforts in past one year to protect the steel industry. Steel companies have recovered from the slump, but they are still looking for a push to promote steel consumption in country. Would the Government's initiatives to spur economic growth with key focus on infrastructure & affordable housing, coupled with opening up of Indian railways rail supplies help the steelmakers in accelerating their turnover at an unprecedented phase?